Companies use different methods for distributing and selling products, including consignment and sale. While these methods have similarities such as moving the products from one party to another, there are significant differences between them with respect to ownership, payment, risks and liabilities.
It is essential for businesses to understand the difference between consignment and sale, as choosing the wrong arrangement may have adverse implications on their finances.
In this article, we will explain what consignment means, what a sale is, how they work, what is the difference between the two their pros and cons, as well as the legal aspects related to them in India.
Definition of Consignment
Consignment is the business arrangement where the owner of the goods consigns the goods to another party for selling but still retains ownership of the goods till they are sold to the final user.
The owner is called the consignor and the other party receiving the goods and selling them is called the consignee.
How Consignment Works
The procedure involved in consignment generally works like this:
- The consignor sends products to the consignee.
- The consignee keeps the products in store and displays it.
- The consignee sells the products to customers.
- The consignee collects the money from the customers.
- The required amount is paid to the consignor.
- The unsold products may also be sent back to the consignor as per agreement.
Such type of practice is very beneficial for the business as it helps in expansion of its market area without selling its stock to other retailers.
Parties involved
Consignor
The consignor is the owner of the merchandise that he sends to another individual for him to sell it on his behalf.
The consignor’s duties may include:
- Supplying merchandise
- Setting the terms and price of goods
- Maintaining ownership of unsold merchandise
- Covering some of the agreed costs
- Getting paid upon sale of goods
Consignee
The consignee receives the goods from the consignor and sells it on his behalf.
The duties of the consignee may include:
- Storing the goods
- Selling the goods
- Maintaining an inventory of goods
- Collecting payments from customers
- Informing the consignor about the sale
- Returning unsold merchandise when needed
This makes the relationship between them be that of principal and agent, with the consignor being the principal.
Definition of Sale
A sale of goods refers to the transfer of ownership of goods from the seller to the buyer in exchange for the payment of a price.
In contrast to consignment, where the ownership is not automatically transferred to the buyer, it normally does so after the transfer of ownership has been made in accordance with the terms of the agreement.
For instance, when a wholesaler makes a sale of 500 pieces of clothing to a retailer, the latter buys the goods and sells them to his/her customers.
How Sale Transaction Takes Place
A sale transaction is done through:
- Buyer placing the order
- Seller accepting the order
- Supply of goods by seller
- Transfer of ownership and risk in accordance with the terms of contract and relevant laws
- Payment of price by the buyer
- Adding goods as part of the buyer’s inventory
Buyer and Seller Rights and Responsibilities
Generally, the seller is responsible for supplying the goods in accordance with the terms of the agreement.
Buyer is supposed to pay for the agreed price and accept the goods.
Comparison between Consignment and Direct Sale with Examples
Suppose there is a cloth manufacturing company which has shipped 1,000 shirts to a retail outlet.
Example 1: Consignment
The cloth manufacturing company has shipped 1,000 shirts to the retailer and holds ownership in them.
The retailer has sold 600 shirts on commission basis and rest 400 shirts may be returned according to the terms of arrangement.
In this case, the manufacturer owns the unsold 400 shirts.
Example 2: Direct Sale
Here the manufacturing company has sold 1,000 shirts to the retail outlet for ₹5 lakh.
In such sales, the buyer holds the ownership of the purchased shirts and even if 600 shirts are sold, the other 400 shirts remain his inventory.
Advantages of Consignment
Consignment can give several advantages to businesses.
1. Larger Market Presence
Manufacturers can sell their goods at many retail stores without requiring retailers to buy stocks in advance.
2. Reduced Entry Barrier for Retailers
Retailers can try new products without a need for significant investments beforehand.
3. More Effective Product Trial
Businesses will be able to get acquainted with customers’ needs before investing in large-scale production or sales.
4. Reduced Inventory Risk for Retailers
Because the unsold products can be returned based on the terms of the consignment contract, retailers can reduce their inventory risks.
5. Increased Product Presence
Goods can be sold via more channels through consignment arrangements with multiple consignees.
Direct Sale Benefits
Here are some of the main advantages of direct sales:
1. Quick Payment
The sellers will get the payments as per the payment terms agreed on without having to wait until the buyers resell their merchandise.
2. Easy Visibility to Revenue
Through direct sales, sellers get more visibility to their revenue and receivables.
3. Ease of Inventory Ownership
The moment the ownership changes, the sellers will no longer own the inventory purchased by them.
4. Reduced Need for Monitoring
The sellers do not need to monitor how buyers are selling their merchandise.
5. Easy Scalability
Wholesale sales can help businesses scale up by selling larger quantities to buyers.
Drawbacks of Consignment
Although consignment offers several benefits, it also comes with certain challenges and some of them are mentioned below:
- Payments will only be made when the product has been sold.
- The consignor still bears the inventory risk.
- Companies must ensure proper inventory management.
- Unsold stock may need to be collected or returned.
- Sales reporting requires frequent co-ordination between the consignor and consignee.
- Issues may arise due to damage, losses or expiry of the product.
- Cash flow becomes uncertain.
Drawbacks of Sale
There are difficulties involved in direct sales:
- The buyer may have to make an upfront investment.
- Retailers are at higher risk of holding unsold inventory.
- Sellers may have less control over how their products are marketed after the sale.
- Products may be non-returnable, depending on the terms of the sale.
- Bulk purchasing can increase the buyer’s working capital requirements.
When should businesses choose consignment?
Businesses may choose consignment when:
- A business wants to enter into a new market.
- A business wants its products to be tested by retailers.
- Retailers are reluctant to purchase products upfront.
- A business wants to increase the visibility of its products.
Example: A newly launched fashion brand would use consignment in order to introduce its products into retail stores and see the consumer reaction before launching production on large scale.
When should businesses choose direct sale?
The situations where direct sales would be a better choice are mentioned below:
- There is a certainty about demand.
- Buyers are ready to buy the inventory upfront.
- The seller needs to generate revenue quickly.
- Large-volume wholesale transactions are involved.
- The buyers need full control over inventory.
- Both parties prefer a simple and straightforward transaction.
Legal Aspects of Consignment and Sale in India
Companies should be aware of the relevant contractual, legal and tax requirements before making such arrangements.
Indian Contract Act – Agency Relationship
Consignment may include the agency relationship between consignor and consignee.
Such agreement must specify:
- Duties of both the parties
- Commission
- Pricing
- Payment Terms
- Ownership of stock
- Responsibility for damage or loss
- Return policy
- Termination policy
Sale of Goods Act, 1930
The Sale of Goods Act, 1930 deals with the various important matters of sale of goods contracts, including conditions and warranties, transfer of property and buyer and seller’s rights.
GST Considerations
The GST treatment will depend on the nature of transaction, the principal-agent relationship and the movement of goods.
Companies must maintain proper tax invoices and records and seek professional advice where the GST treatment of an arrangement is unclear.
E-Way Bills
The movement of goods may require filing of e-way bills depending on the nature and value of the movement, and other factors of GST.
Companies need to confirm their requirements for E-way bills before transporting their goods.
Key Terms of Consignment
Knowing about these terms will help you handle your consignment transactions easily:
Consignor
The owner sending the goods for sale.
Consignee
The party receiving and selling the goods on behalf of the consignor.
Consignment Goods
The goods being kept by the consignee but still belong to the consignor until they get sold.
Commission
The compensation made to the consignee for selling the goods.
Pro Forma Invoice
The invoice that may be used to accompany goods when sent for consignment, and it is not, by itself, a final sales invoice.
Consignment Contract
The agreement between both parties detailing their terms and conditions.
Principal
The party giving its authority to another party (the agent) to act on its behalf.
Agent
The party acting on behalf of the principal.
Common Mistakes Businesses Make
These are the common mistakes businesses make while managing their consignment or sale transactions:
1. Lack of Definition of Who Owns the Products
It must be clearly stated whether the products belong to the business owner or not at each stage.
2. Lack of Proper Management of the Inventory
The visibility of inventory can become difficult when distributed across multiple consignees or locations.
3. Not Mentioning Payment Terms
Failure to clearly define terms of commission, payment schedules, deductions and settlement can lead to payment disputes and delays.
4. Not Addressing Damage, Loss or Expiry of the Products
Failure to define responsibility for damaged, lost or expired goods can lead to financial losses and disputes between the parties.
5. Inadequate Reporting on Sales and Inventory
Lack of regular reporting on sales and inventory levels can result in poor inventory visibility, stock discrepancies and delays in reconciliation.
Best Practices in Consignment Management
Organizations can improve their consignment processes using the following best practices:
- Draft a detailed consignment agreement.
- Keep or maintain real-time inventory data.
- Specify payment terms.
- Determine liability for damage and loss of goods.
- Specify timelines for return of unsold items.
- Monitor sales performances of consignees.
- Conduct regular inventory reconciliation.
- Use logistics and inventory software.
- Review consignee performance.
In organizations that deal with high volume, technology can be used to monitor inventory movements, shipping, performance and returns of shipments more efficiently.
Conclusion
It is important for businesses to distinguish between the consignment and the sale arrangements dealing with the distribution or sale of goods through third parties.
In case of consignment, the goods remain the property of the consignor till they are sold, and the consignee earns a commission on the sale. In the case of the direct sale model, the ownership of the goods passes to the buyer in accordance with the agreement and the buyer becomes responsible for the management of the inventory.
FAQs
What is the main distinction between consignment and sales?
Main distinction is about ownership, as the consignor is a usual owner until the goods are sold. On the contrary, in case of sales, the ownership passes to the buyer according to the agreement.
Who owns the goods in case of consignment?
In most cases, the consignor is an owner until the goods are sold to the final client. Consignee holds and sells the goods on behalf of consignor.
How does a consignor differ from consignee?
A consignor is an owner who sends goods for selling, whereas consignee receives and sells the goods on behalf of consignor.
Is consignment a sale?
Consignment is not a sale from the consignor to the consignee, since in this case the ownership does not pass to the consignee just by delivering goods.
Who bears the risk in consignment?
The consignor keeps inventory risk as they are the owner of the goods but the responsibility for losses or risks is determined in accordance with what is specified in the agreement.
